Overdraft debt is one of the easiest debts to get into. It’s attached to your current account, which is both a blessing and a curse. You don’t need to apply for separate credit to be given an overdraft.
Overdrafts are, perhaps, the most accessible form of debt. Most people have a current account, and many of these come with overdrafts that you’ll claim without even thinking.
How Do Overdraft Interest Work?
Because overdraft interest is charged monthly, you will incur a lot of extra costs over time, even on a small overdraft balance. Many customers struggle to get out of an overdraft due to the charges they pay every month.
Whilst you have to make an active decision to apply for a credit card or loan, overdrafts are given almost automatically when you apply for a bank account.
So, it’s no surprise that nearly 13 million people are in overdraft debt every year.
Read on for more information about overdraft debt and how to manage it.
- – How do overdraft interest rates work?.
- – Personal Loan Debt.
- – How to get a personal loan with bad credit.
- – Understanding Store Card Debt.
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Why Overdraft Debt Is a Problem
When you apply for a bank account, you’re likely to be offered an overdraft. Most current accounts advertise an overdraft ‘up to’ a certain amount, and the size of your overdraft will depend on your credit score and borrowing history.
Your overdraft isn’t a separate line of credit, which makes it more difficult to manage. You don’t have to make an active decision to apply for your overdraft initially, and you can easily get into your overdraft just through your everyday spending. Your overdraft is attached to your everyday debit card.
An overdraft is an extension of your bank account balance. If you overspend, you can dip into your overdraft and not even realise that you’re doing it.
It’s easy to get into overdraft debt. This can make your overdraft dangerous. It gets very tempting to spend just a bit more than you can actually afford.
Once you’re in your overdraft, you’ll need to make a more active effort to get yourself back out of debt. Banks will also charge fees and interest, so you’ll soon end up in higher levels of debt.
How People Get Into Overdraft Debt
For this example, we’ll use Sam. Sam has a current account with a £500 overdraft. Sam is usually good at keeping control of his budget.
One day, Sam is grocery shopping at the end of the month. He has £40 left in his bank account, but accidentally spends £50 on groceries. He automatically goes £10 into his overdraft.
Going into his overdraft felt easy. Sam hardly considers his overdraft to be a form of debt. Attached to his current account, Sam’s overdraft feels like his own money. Sam’s soon tempted to spend a little more on something he can’t actually afford.
Suddenly, Sam has a £150 overdraft. The bank adds charges and fees, pulling him further into debt.
The next time Sam gets paid, his wages are first used to clear his overdraft debt. He receives £1,400 from his employer. Sam’s now overdraft-free and only has around £1,200 remaining.
Sam’s budget is usually stretched. He usually spends around £1,400 a month. To do that this month, he’ll need to dip into his overdraft again. This month, he’ll end up around £200 into his overdraft. The bank will add further charges and fees. Every month he’ll get into more debt.
Soon, Sam is one of an estimated 2 million people stuck in a permanent overdraft.
The Costs of Overdraft Debt
Overdraft debt is particularly dangerous because it’s so easy to get into, and because it’s one of the most expensive forms of everyday borrowing. In fact, nowadays, overdrafts are often more expensive than payday loans.
Overdraft charges can be as high as 40% of your borrowing. It’s easy to see how this debt can soon spiral to an unmanageable level.
Many people never get out of their overdraft. Every month their income clears some of their overdraft debt, but they’re left with nothing to use on their everyday spending. Their only option is to use their overdraft again for their day-to-day purchases.
Because an overdraft is attached to a bank account, there’s no way to separate the two. With a credit card you can choose to clear your debt or not, but with an overdraft you have no control. An overdraft becomes an extension of your bank balance, but the money isn’t really yours at all.
Overdraft Debt Statistics
|Type of Debt||% of customers with the debt 2017||Average||% of customers with the debt 2018||Average||% of customers with the debt 2019||Average|
What this shows is that, despite overdraft debt still being a problem, it is gradually getting smaller each year. This may be because banks are tightening lending criteria, and people are forced to turn to other sources of credit with higher interest rates.
Getting Out of Overdraft Debt
To get out of overdraft debt, you’ll need to pay more into your bank account than you’re taking out each month. This doesn’t just mean sticking to your budget, but also finding money to cover any overdraft charges.
If you’re used to spending every penny you earn, you’ll have to work hard to reduce your monthly budget so you can start to climb out of debt. It can take many months, and even years, to slowly get out of your overdraft.
To get out of overdraft debt, work out how much you’re being charged every month. This is the minimum amount that you’ll need to save. If you’re getting charged £35 a month, try and find a way to cut at least £45 from your monthly budget each month. You’ll slowly reduce the amount that you owe, and consequently how much your bank charges.
Avoiding Overdraft Debt
Avoid overdraft debt in the first place by cutting off your access to an overdraft. It’s possible to find current accounts that don’t come with an overdraft facility. You can also contact your account provider and ask them to remove your overdraft, so that you never have access to this money.
If you have an account without an overdraft, you won’t be allowed to overspend. If you don’t have enough money to cover a purchase, your card will be declined at the checkout.
If you’re worried that you’ll be tempted to apply for an overdraft again, you can consider other options like using a prepaid card. These usually come with small charges, but you’ll need to load the card with money from elsewhere and can only spend what’s already yours. With a prepaid card, an overdraft facility will never be an available option.
Can Banks Take an Overdraft Back?
If you have an overdraft that you’re currently using, don’t depend on it staying available. Banks can reclaim their overdraft at any time.
Overdrafts are big money makers for banks, so they’re unlikely to remove them without cause, but if yours is taken you’ll need to pay it back as soon as possible.
If you can’t afford to repay your overdraft immediately, you’ll need to come to some sort of agreement with your bank. They may remove your access to your overdraft, then require you to make a monthly payment until your overdraft debt has been paid off.
If your bank suddenly closes your overdraft, you may be left with no usable money. It’s important not to rely on your overdraft as your only source of spending money.
Quick Overdraft FAQs
As it’s relatively easy to get and use an overdraft, many people mistakenly believe that overdrafts are a cheaper debt. In fact, overdrafts can become very expensive and may even cost more than payday loans.
Different banks may offer different overdraft buffers. This is how much you’ll be allowed to borrow before the interest charges start.
Banks use EAR as this takes compound interest into account. Essentially, this tells you how much you’d owe if the interest was added each month. EAR is more accurate than APR because it doesn’t base your percentage rate on just your original debt.
The effective annual interest rate is the real return on a savings account or any interest-paying investment when the effects of compounding over time are taken into account.
An APR is representative if it’s the rate that will be given to at least 51% of successful applicants. Remember that lenders can adjust the APR to suit different types of customer. When you see a representative APR, this isn’t necessarily the price that the lender will offer.
How Can Money Savings Advice Help You Reducing Your Debt?
Here at Money Savings Advice, we have partnered with some of the UK’s debt release brokers. They have already helped thousands of people reduce and remove a high percentage of debt, and if you are struggling with debt, they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these brokers, then click on the below and answer the very simple questions.